Borrowing, Home Purchase Loan, Insurance, Other Insurance

If you are a first-time homebuyer, you may be aware of mortgage insurance but you may not know that there are two different types. Mortgage Insurance Premiums (MIP) and Private Mortgage Insurance (PMI) both have the same general purpose: to offset the default risk to lenders when borrowers have purchased homes with low down payments (below 20%). Mortgage insurance does not protect buyers; it protects lenders from the potential default of buyers.

There are some significant differences between PMI and MIP. PMI applies to conventional loans with more traditional down payments and protects the lender (or the investor who buys the debt as a mortgage-backed security). MIP applies to FHA government-backed loans. In both cases, the insurance costs are passed on to buyers, but in the case of PMI, the mortgage insurance is supplied by a third party.

PMI offers more flexibility in terms. It can be paid as a lump sum at closing or financed along with the home and incorporated into monthly mortgage payments. PMI amounts vary based on the size of the loan and individual risk factors such as the loan-to-value ratio (LTV), a measure of how much initial equity the buyer holds. Rates for PMI can range anywhere from 0.5% to 2% of the loan amount.

In most cases, PMI must be removed at 78% LTV and borrowers can request that PMI be removed after the LTV ratio reaches 80%. At closing, buyers should be informed of when PMI can be removed assuming regular scheduled payments are made. Some lenders may be willing to forgive PMI at a higher LTV ratio if they feel that the buyer no longer poses a significant default risk.

MIP is associated with FHA loans that have low down payments, as low as 3.5% in some cases. As a result, the default risk is higher and the mortgage insurance premiums have less latitude in terms.

MIP has two components: an upfront premium (UFMIP) and an annual premium. The current upfront premium rate is 1.75% of the loan amount and the current annual premium is 0.85% for the most common category of FHA loans (LTV’s of 95% or above, loans of $625,000 or below, and payments for the term of the mortgage). Annual premiums can be lower for lower LTV values or mortgage terms of fifteen years or less.

UFMIP is often financed and added to the mortgage amount because it does not count against the LTV value that is used to determine other thresholds. It is also likely that buyers acquiring an FHA loan at a low down payment do not have the cash on hand to pay UFMIP directly.

Generally, the only way to remove MIP is through a full refinancing. By meeting improved down payment and credit requirements on the refinancing, risk to the lender is reduced and MIP is no longer necessary. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.

What type of mortgage insurance is best for you? That depends on your individual situation, but PMI is usually preferable to MIP because of the improved flexibility of terms, frequently lower rates, and potential to be removed over time. Online calculators are available to help you determine your MIP and/or PMI for whichever path you choose.

However, if you can afford to put the standard 20% down payment toward a home, you can avoid mortgage insurance altogether — the best outcome of all. Be sure to consider insurance costs when determining the size of mortgage that you can afford.

MoneyTips is happy to help you get free refinance quotes from top lenders.

Photo ©iStockphoto.com/AlexRaths

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